Dissolution of Partnership Firm – Meaning, Grounds And Consequences

The term ‘firm’ is defined under Section 4 of the Indian Partnership Act as “two or more people who have entered into a partnership with one another are individually called as partners and collectively a firm”. While under Section 39 ‘the dissolution of a firm’ is explained as “The dissolution of a partnership between all the partners of the firm”. In simple words, it is a termination of the firm when all the respective partners abstain to continue their partnership.

However, it is important to understand that dissolution of a firm and the dissolution of a partnership are not the same as each other. Whenever there is a dissolution of a firm it will entail the dissolution of a partnership too, while vice versa is not certainly true.

Let us assume there are three partners A, B and C of the firm XYZ. C wants to discontinue his partnership in the XYZ firm. Here, C is supposed to settle all the liabilities either by transferring them to any of the partners (A or B) or by selling off his assets. So, in this illustration, there is dissolution of the partnership of C but the dissolution of XYZ firm is not involved. Hence, A and B are still continuing as partners in the XYZ Firm.

Grounds For Dissolution of Partnership Firm

Dissolution of a partnership firm can take place in two ways:

  1. Dissolution without the intervention of the Court (covered under Section 40 to Section 43 of the Indian Partnership Act, 1932)
  2. Dissolution by the Court (mentioned under Section 44 of the Indian Partnership Act, 1932)

Section 40: Dissolution by Agreement

The dissolution of a partnership firm can be done at any time when all the partners of the respective firm give their consent to do so. It may be a partnership at will or partnership for a fixed term. However, dissolution should be in accordance with the terms of the contract between them.

Section 41: Compulsory Dissolution

It is mandatory to dissolve a Partnership Firm when any of the hereunder mentioned events occur:

  1. When all the partners of the firm are declared to be insolvent or except for one partner all others are declared to be insolvent by a competent court.
  2. When the business becomes unlawful to be carried on because of the occurrence of some event. However, in a situation where a firm is involved in more than one task or business then the firm is not liable to be dissolved in respect of its lawful adventures due to the illegitimacy of a particular undertaking.

Section 42: Dissolution on the Happening of Certain Contingencies

A firm shall be dissolved when any of the below-mentioned contingent or unforeseen event takes place:

  1. When a firm is constituted for a fixed period of time, so on expiration of the said term the firm is to be dissolved.
  2. When a firm is created particularly for carrying out one or more tasks, then after the completion of those undertakings the dissolution of the partnership firm will take place.
  3. When any of the partners die, the partnership firm automatically stands dissolved, unless there is a clause in the partnership deed which mentions that the death of any partner will not lead to the dissolution of the partnership firm.
  4. When a partner is declared as insolvent, the partnership firm dissolves. This can be stopped if there is any provision in the contract which opposes dissolution on insolvency of a partner.

Section 43: Dissolution by Notice of Partnership at Will

  1. When the partnership is at will any partner can dissolve it by giving written notice to other partners wherein the intention of the respective partner to dissolve the firm is mentioned.
  2. The firm stands dissolved from the date mentioned in the notice for the dissolution of firm. In case no date is mentioned in the notice, then the date on which communication of notice took place will be considered as the date of dissolution of the partnership at will.

Section 44: Dissolution by the Court

The court has the power to pass an order to dissolve a partnership firm on the following basis:

(a) Insanity or Unsoundness of Mind

The insanity of a partner can be a ground for other partners to approach the court to get an order for the dissolution of partnership firm.

(b) Incapacity to perform duties

When a partner becomes permanently incapable of discharging his duties then the court on the application of other partners (s) may pass an order for dissolution of the firm.

(c) Misconduct

When the conduct of the partner has prejudicially affected the business and incurred a huge loss, the other partner(s) can file a suit in the court of law and order for dissolution of the firm may be passed by the respective court.

(d) Breach of agreement

When a partner continuously and knowingly breaches the agreement related to the conduct of their business and management of various affairs of their firm or indulges in unreasonable conduct of the business, makes it difficult for other partner(s) to continue their partnership. Hence, the other partner(s) who seek dissolution of the partnership firm can approach the court.

(e) Transfer of Interests

When a partner sells off all his interests or shares in the firm to a third party or has attached or sold his partnership property to a third party, the other partner(s) can sue him and court can pass the order to dissolve the firm.

(f) Continuous loss in business

When a partnership firm is consistently incurring losses and there is no possibility of any growth in the future then the court can order for dissolving the partnership firm.

The court may pass an order for dissolution of partnership firm on other grounds as well other than those mentioned which it feels to be just and equitable.

Consequences of Dissolution

After the dissolution, it is not possible to wrap up all the undertakings and business of the firm in one day rather it is a time-consuming process. The partners of the firm need to perform certain functions and have to face some consequences as mentioned under some sections of the Indian Partnership Act, 1932.

Section 45: Liability for acts of partners done after dissolution

The dissolution of partnership firm does not mean that the partners can escape the liability to the third party or parties for their actions unless any public notice is issued informing about the same. Any partner who has died, declared insolvent, retired from the firm or been removed from the firm are not liable under this section from the date their partnership ended due to these reasons.

Section 46: Rights of partners to have business wound up after dissolution

After the dissolution of partnership firm every partner or their representative have the right over the firm’s property to pay off the debts and other liabilities of the respective firm. While the remaining surplus amount is to be distributed among all the partners or their representatives according to the share they hold in the firm.

Section 47: Continuing authority of partners for purposes of winding up

In spite of the dissolution of a firm, the authority to bind the firm and all the other obligation and mutual rights of the partners remains unaffected, so far as may be considered necessary for winding up the undertakings of the firm and to conclude all the transactions that remained unfinished at the time of firm’s dissolution.

Section 48: Mode of settlement of accounts between partners

This section defines the ways by which accounts of the firm can be settled. The losses which also include the deficiency of capital shall be paid by the firm and then out of the partner’s capital and lastly, if required, by the partners individually which will be proportional to their profit-sharing in the firm. The firm’s assets and the amount collected by the partners after clearing all the debts and dues, the residue amount shall be divided among the partners according to the ratio of their share profits.

Section 49: Payment of firm debts and of separate debts

When a firm has joint debts due and any partner has separate debts due, the firm’s property shall be applied firstly for paying the debts of the firm and after that if any amount is left, then it shall be given to them according to their shares to pay their separate debts or in case any partner doesn’t have a separate debt then also it is given to them.

Section 50: Personal profits earned after dissolution

After the dissolution of a firm, if any partner earns some person profit from the firm’s transactions, property, business or name of the firm then he has to share the profit with other partners or their representatives.

Section 51: Return of premium on premature dissolution

On dissolution of the firm before the fixed term, the partner liable to get back the amount he paid as premium when he entered into the partnership for the fixed period. However, he cannot claim it if dissolution was an outcome of his misconduct or the absence of any provision for repayment of premium on dissolution.

Section 52: Rights where partnership contract is rescinded for fraud or misrepresentation

When a partnership contract is rescinded on the ground of misrepresentation or fraud, then the other partners can use certain rights such as lien on the firm’s surplus assets, indemnify the debts and also has the right to become the creditor for the payments of the firm.

Section 53: Right to restrain from use of firm name or firm property

After the dissolution of partnership firm, every partner has the authority to stop other partner from using the firm’s name to continue a similar business and from using the firm’s property for any personal benefit, till the business of the firm has been completely wrapped up. But this can be done only when there is no contract to oppose it.

Section 54: Agreements in restraint of trade

After the firm’s dissolution, partner can enter into an agreement for imposing reasonable restrictions on all or some partners like not to undertake a similar business as that of firm for specific time period or within the specified geographical limits.

Section 55: Sale of goodwill after dissolution

Goodwill is considered as an asset when the firm’s accounts are settled after dissolution. It can either be sold separately or along with the firm’s other property. The partners may carry on the same business after selling the goodwill but cannot use the name of the firm. Moreover, there can be restraint of trade on selling the goodwill as partners may be asked to not carry the same business or there can be restriction related to time or geographical area.

In this article, we have discussed in detail the meaning of dissolution of a firm, the various grounds of dissolution and the consequences of dissolution with the help of various sections of the Indian Partnership Act, 1932.

This article has been authored by Radhika Garg, 2nd Year, BA.LLB. student at Symbiosis Law School, Hyderabad.

Also Read – E Contract – Meaning, Essentials And Territorial Jurisdiction

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